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Salary sacrifice checklist

One of the outcomes of a salary sacrifice arrangement can be to help generate pension contributions for employees. Many providers offer a salary sacrifice calculator to help with the calculations and Aegon’s individual and bulk spreadsheets can be found here. These offer the following two options:

Keep net income constant - this allows an employee to maintain the same take-home pay and increase their pension contribution by sacrificing some of their salary. The employee contribution before sacrifice changes to a higher employer contribution after sacrifice.

Keep pension contributions constant – this allows an employee to maintain the same pension contribution and increase their take-home pay by sacrificing some or their salary. The employee contribution before sacrifice changes to an employer contribution after sacrifice.

The main difference between the two options is that for the Keep net income constant option the employee national insurance saving is added to the pension contribution after sacrifice whereas for the Keep pension contributions constant option it is added to the take-home pay after sacrifice.

Putting the salary sacrifice arrangement in place involves several steps that could involve many parties including the employer, their payroll provider, their financial adviser, the employees and the pension provider chosen to administer the scheme. It’s imperative that a suitable process is followed so that the salary sacrifice is clearly documented and that the resulting contributions are correctly applied to the provider’s pension scheme. As a guide, here’s a brief checklist highlighting the main steps and issues to take account of:

One of the first steps in the process could be for the employer to decide that they want to offer salary sacrifice. Following on from that a decision will need to be made on which quote option to use and how much of the employers’ National Insurance (NI) savings will be added (if any) to help boost the pension contributions post sacrifice. Remember, an employee can only sacrifice future earnings, which can either be regular earnings or a contractual bonus that has yet to be received.

The employer may want to hold an initial informal discussion with the employees to explain how salary sacrifice works and the benefits of using it for pension contributions. They are also likely to prepare salary sacrifice literature for employees to aid their understanding. The literature may include additional information relating to opting out of salary sacrifice when a lifestyle event occurs, the employer using a notional salary for other employee benefits and the effect on State benefits that a reduction in gross salary may have.

It’s worth pointing out that HMRC guidance(Opens new window) confirms a salary sacrifice arrangement can’t reduce an employee’s gross earnings below National Minimum or Living Wage rates, so salary sacrifice won’t be suitable for these employees. At the other end of the pay scale, consideration needs to be given to higher earners who may be subject to the tapered annual allowance or who could be if they agree to the salary sacrifice arrangement.

Quotes can be produced from a salary sacrifice calculator tailored to the requirements the employer wants to use for their salary sacrifice arrangement. Quote inputs will typically ask for the quote option, the pre-sacrifice salary and pension contributions plus how much of their NI saving the employer is adding in. There may also be questions asking if the employee is an apprentice or a Scottish taxpayer to make sure the relevant tax and NI rates and bands are used.

The output from a salary sacrifice quote will vary depending on the pre-sacrifice salary and pension contributions, the type of quote requested and the employer NI savings being added. So, it’s important to do a sense-check of each quote after it’s been produced to make sure it is in line with the intended quote basis and the details that were input.

The quote output will normally include a copy of the quote plus a covering letter for the employee confirming the details of the salary sacrifice. The letter will typically state the date the sacrifice will take effect, the amount of the sacrifice and the change in pension contribution or take-home pay. Aegon’s covering letter allows it to be used to provide a sign-off for the salary sacrifice. This is done by employees agreeing both to opt-in and to the change in their terms and conditions.

For employees that have agreed to use salary sacrifice, the employer should then communicate details of the changes that will apply to each employee and take steps to adjust PAYE records to ensure the correct salaries will be used post sacrifice. If the outcome of the salary sacrifice is that only employer contributions are paid after sacrifice, then there should be no employee contributions deducted from an employees pay after the sacrifice has been implemented.

Returning to the HMRC guidance(Opens new window) referred to earlier, it’s possible for an employer to ask HMRC (Clearances Team) to confirm that a salary sacrifice arrangement is effective once it is in place.

It’s important to make sure that the correct contribution details are given to the pension provider when contributions are paid post sacrifice so that the pension provider applies the right amounts to each employee’s policy and records the correct type of contribution (employer or employee). Often, a pension provider may not know that salary sacrifice is being used for a pension scheme they are administering and the main clue may be that only employer contributions are being made. Any inaccuracies or misunderstandings could result in the wrong type of contributions being applied resulting in an admin exercise to rectify any errors, which is something to avoid if at all possible.

Once a salary sacrifice arrangement is in place for a pension scheme, the employer can then offer new employees the option of joining the scheme on a salary sacrifice basis. If necessary, this can be run in parallel with any automatic enrolment duties that an employer may have.

On an ongoing basis, an employer offering salary sacrifice may want to review existing calculations regularly (for example, where salaries are increased on an annual basis).

Salary sacrifice isn’t an easy concept to get to grips with. However, adopting and following a set process when introducing a salary sacrifice arrangement should help ensure that it is implemented correctly with the benefits (and possible implications) of doing so being clear to both employers and employees.